May22 , 2022

Ahead of Fed hike, the worry: RBI behind curve



Less than a month ago — on April 8 — the Reserve Bank’s Monetary Policy Committee (MPC) had decided to keep the policy Repo rate unchanged at 4 per cent despite rising inflation and heightened global uncertainty following Russia’s attack on Ukraine.

The sudden action to hike the rate by 40 basis points on Wednesday, experts said, was prompted probably due to some understanding within RBI about a higher retail inflation print in April, a sharp hike in rate by US Fed, and deep worries over domestic food prices given their sensitivity in India’s political economy.

As it turned out, the US Fed raised its overnight benchmark rates by half a percentage point nine hours after RBI action on Wednesday. This 50-basis point increase by the US Fed is the biggest jump in 22 years, according to Reuters. Its biggest concern remained inflation, with the war in Ukraine and new coronavirus lockdowns in China threatening to keep pressure high.

In India, the headline CPI (Consumer Price Index) or retail inflation jumped to 6.95 per cent in March 2022 as anticipated in the RBI’s April policy statement. The RBI has now indicated the print for April is likely to be elevated.

Some analysts have been warning that the RBI has fallen behind the curve in tackling inflation. There were clear indications too. The yield on the 10-year benchmark bond has already crossed the 7 per cent level. “My concern is that the accommodative stance carries with it the risk of falling behind the curve in future because the stance limits the MPC’s freedom of action in ensuing meetings,” RBI policy panel member Jayanth Varma had told The Indian Express in an interaction in March this year.

A senior fund manager with a leading asset management company said the RBI decision is also linked to an expected hike by the Federal Reserve Bank. “Rate hikes by the US Fed are leading to big outflow of funds and are putting pressure on rupee requiring currency management by the RBI. While the rate hike had to be done, the timing of it being done just ahead of the Fed Rate hike is not a mere coincidence,” the fund manager, who did not wish to be named, said.

Some economists pointed to the RBI statement which reflected serious concerns over rising food prices. “The logical underpinning of RBI hike today and away from the regular policy date is the rising concern on inflation – especially with regards to food. Food inflation, more than the non-food inflation, can change inflation expectations in India drastically,” said Indranil Pan, Chief Economist, Yes Bank.

According to RBI Governor Shaktikanta Das, geopolitical tensions are ratcheting up inflation to their highest levels in the last 3 to 4 decades in major economies while moderating external demand. “Global crude oil prices are ruling above US$ 100 per barrel and remain volatile. Global food prices touched a new record in March and have firmed up even further since then. Inflation sensitive items relevant to India such as edible oils are facing shortages due to the conflict in Europe and export bans by key producers,” he said.

The jump in fertiliser prices and other input costs has a direct impact on food prices in India. The sharp acceleration in headline CPI inflation in March 2022 to 7 per cent was propelled, in particular, by food inflation due to the impact of adverse spill-overs from unprecedented high global food prices. Nine out of the twelve food sub-groups registered an increase in inflation in March, the RBI said.

The RBI indicates that high frequency price indicators for April indicate the persistence of food price pressures. Simultaneously, the direct impact of the increases in domestic pump prices of petroleum products – beginning the second fortnight of March – is feeding into core inflation prints and is expected to have intensified in April. Looking ahead, food inflation pressures were likely to continue, it said.

The persistence of high crude oil prices and uncertainty over the length of the Russia-Ukraine war have resulted in sustained inflationary pressure globally. With the Chinese and Japanese currencies depreciating 4 per cent and 6 per cent respectively last month, emerging market currencies are under pressure. “Although the rupee has depreciated only 1.1 per cent in the past month, any further downward pressure on the rupee would spark greater worries about imported inflation, so a timely rate hike was needed ahead of the inevitable US rate hike expected this week,” said Prasenjit Basu, Chief Economist, ICICI Securities.

According to an RBI survey released last month, inflation expectations of households across various cities for three months and one year ahead have crossed the 10 per cent level. “Households’ median inflation perceptions for the current period remained unchanged at 9.7 per cent in the latest survey round, while the expectations for both three months and one year ahead rose by 10 basis points each to 10.7 per cent and 10.8 per cent, respectively, as compared to January 2022 round,” the RBI’s Inflation Expectations Survey of Households said.

“There is the collateral risk that if inflation remains elevated at these levels for too long, it can de-anchor inflation expectations which, in turn, can become self-fulfilling and detrimental to growth and financial stability,” RBI Governor Das said.

As the war draws on and sanctions and retaliatory actions intensify, shortages, volatility in commodity and financial markets, supply dislocations and, most alarmingly, persistent and spreading inflationary pressures are becoming more acute with every passing day. Debt distress is rising in the developing world amidst capital outflows and currency depreciations. Recent GDP releases suggest that the global economic recovery is losing pace, he said.

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